A Defensive Play: Morgan Stanley Upgrades The Utilities Sector

The stock market may be getting more defensive right under investors’ noses. According to a new note from Morgan Stanley analyst Michael Wilson, it’s a great time for investors to go defensive by buying utilities stocks.

Morgan Stanley has upgraded the utilities sector to Outperform, and Wilson said the fact that stock prices aren’t keeping pace with earnings growth so far in 2018 suggests the market may be subtly pricing in slowing earnings growth down the line.

A Forecast For Outperformance In Utilities

A significant divergence has occurred so far this year between the most risky and least risky assets, the analyst said. Nasdaq and small cap stocks have lead the charge so far this year, with low-risk assets such as investment-grade bonds and U.S. Treasuries lagging.

“Last year, this ‘risk on’ performance ranking would have seemed natural to us given the extremely strong and broad performance of global equities, but we think this pattern continuing for the duration of 2018 seems unlikely,” Wilson said.

In the near-term, Wilson expects mean reversion will result in relative outperformance for low-risk assets such as utility stocks. For now, Morgan Stanley will be watching 10-year Treasury yields closely for a signs that the tide is beginning to turn.

The inability of the 10-year Treasury yield to break above 3 percent last week coupled with the inability for financial stocks to gain any traction could be an indication that the “risk on” trade has already begun, Wilson said.

Morgan Stanley recommends the following Overweight-rated utility stocks:

• American Electric Power Company Inc AEP
• FirstEnergy Corp. FE
• NextEra Energy Inc NEE
• Nextera Energy Partners LP NEP
• PG&E Corporation PCG
• Public Service Enterprise Group Inc. PEG
• Xcel Energy Inc XEL

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